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BancorpSouth Inc (NYSE:BXS)

F4Q07 (Qtr End 12/31/07) Earnings Call

January 24, 2008 11:00 am ET

Executives

Randy Birchfield - Senior Vice President

Aubrey Patterson – Chairman, CEO

Jim Kelley, President - Chief Operating Officer

Nash Allen - Chief Financial Officer

Gregg Cowsert - Chief Lending Officer

James Threadgill -Vice Chairman

Analysts

Barry McCarver - Stephens Inc.

Brian Clark - KBW

Dave Bishop

Operator

Welcome and thank you for standing by. Operator Spencer currently in a listen-only mode. As a reminder, today’s conference is being recorded. If you have any objections, you may disconnect at this time.

I would now like to turn the call over to BancorpSouth’s Randy Birchfield. Mr. Birchfield, you may begin.

Randy Birchfield, Senior Vice President

Good morning. I want to call today from our open offices in Tupelo. BancorpSouth Chairman and CEO, Aubrey Patterson; Jim Kelley, President and Chief Operating Officer; Nash Allen, Chief Financial Officer; Gregg Cowsert, Chief Lending Officer; and James Threadgill, Vice Chairman of our Financial Services Group which includes our insurance operations.

As usual, let me remind you that during today’s call, representatives of BancorpSouth may make certain comments and statements regarding future results or future financial performance of BancorpSouth. We caution you that as results could differ materially from those indicated in these forward-looking statements due to a variety of factors and/or risks. Also during the call, certain non-GAP financial measures may be discussed regarding BancorpSouth’s performance, so you can find a reconciliation of these measures to GAP financial measures in the industrial relations portion of our website at www.bancorpsouth.com. Now, BancorpSouth’s Chairman, Aubrey Patterson.

Aubrey Patterson, Chairman

Thank you, Randy and good morning. Thanks to each of you for being with us today to discuss BancorpSouth’s financial results for the fourth quarter. I will give you a brief overview of our highlights for the quarter and then other members of the single management team and I will address any questions you have.

Let me begin this morning by saying we are pleased with the fourth quarter performance of BancorpSouth as it is strong. The financial services industry faced substantial challenges during the quarter due to a slowing economy, housing and energy issues, and a softer insurance market. Many in the industry were significantly affected by losses related to the sub-prime mortgage market.

In this environment, our strong performance for the quarter stood out from our pier group. We provided solid organic loan growth, expanded our net interest margin, maintained strong credit quality and balance sheet liquidity, and continued to achieve significant growth in both no-interest revenue and non-interest revenue. As a result, net income increased 14.8% and diluted earnings per share increased 11.4% for the quarter, compared with the fourth quarter of 2006. This growth was driven by the strong performance of the company’s traditional banking business which produced a comfortable quarter increase in net interest revenue of 13.9% following an 11.9% increase in the third quarter.

Fourth quarter expansion in net interest revenue again looks like it is significant growth in net loans and leases which increased 16.6%. That was primarily due to the acquisition of the Signature Bank in March of 2007. In addition, we continued to produce solid organic loan growth, with loans up sequentially from the third quarter at an annualized rate of 5-1/2%. Our move to degenerate organic loan growth in this current environment at a rate up from the third quarter is indicative of the strength of the diverse markets in our company’s eight-state franchise. As discussed in the news release yesterday, our mid-South geographic footprint includes sound local economies that have grown at attractive rates. These markets are not immune to national economic trends. In our experience, nonetheless, they can be steadier performers throughout the entire economic cycle than can those markets that expand rapidly in economic upturns.

BancorpSouth’s asset liability and management strategy has also contributed to the growth in non-interest revenue for the fourth quarter. Consistent with our tactics over the last several quarters, we have continued to fund loan growth on maturing, low-yielding investments. Reducing the company’s dependence on certificates of deposit to fund loan growth has enabled us to continue restructuring the liability side of the balance sheet. This restructuring has reduced savings and other time deposits by approximately $440 million since the end of the first quarter. During that same period, we replaced these deposits with less expensive federal home loan bank borrowings.

There are two important points that I will add to this discussion about restructuring our sources of funds. First, as we have discussed with you before, the focus of our efforts to reduce cost was primarily on dealing with the size and the use of public fund time deposits provided by state, federal, and local governments which require securing as well. However, we can at any time resume use of these funds when market conditions call for it. This strategy does not in any way deal with the size of our commitment to the company’s core customer relationships.

On the contrary, by restricting the growth of interest expense, these moves to restructure the company’s liabilities improve our flexibility to serve the needs of our core customers. In addition, the successful implementation of the restructuring strategy illustrates our strong and well-managed liquidity position. The company continues to have sizeable and more than adequate sources of additional liquidity as may be required in the future. The ultimate effect of this conservative, positioning strategy is to manage both our assets and liabilities is other than the high rate of growth and asset yields versus the average rate pay-to liabilities to the comparable fourth quarters of 2007 and 2006. As interest rates declined beginning in late September, the time when the average rate paid for the fourth quarter compared with the third quarter exceeded the decline in asset yields for the same period.

In line with the company’s expanded loan volume, the favorable changes in asset yield and average rates pay-to liabilities, though with similar dynamics in interest revenue and expense. Comparable quarter interest revenue experienced a faster rate of growth than did interest expense for the fourth quarter. As interest rates declined sequentially, interest expense declined at a faster rate than did interest revenue. In addition to producing a second consecutive quarter of double-digit growth and net interest revenue, this combination of repositioning of assets, liabilities, and favorable movement in interest rates resulted in an increase in net interest margin for the fourth quarter to 3.72%, the highest level in the past six quarters, and up from 3.64% in the fourth quarter of 2006.

Another facet of the strong performance of BancorpSouth’s traditional banking business for the fourth quarter was our continued higher credit quality. As a percentage of loans, year-end non-performing loans expanded two basis points to 32 basis points from 30 basis points at the end of 2006, and both this percentage and the dollar amount in non-performing loans fell from the end of the third quarter of 2007. All the large net charge-offs were 0.21% of loans for the fourth quarter, which is an improvement over 0.25% for the second quarter in 2006. Charge-offs did increase from an unsustainably low 13 basis points annualized rate for the third quarter although they remained at the lower range, consistent with our historic operations. This sequential quarter increase obviously contributed to the increase in other real estate-owned at year end. We know decisively to recognize the credit losses associated with these loans, and we expect to liquidate these properties without additional material loss.

As a result of all these factors, we increased the provision for credit losses in the fourth quarter to $7.8 million. Our allowance for credit losses totaled 1.25% of loans at the end of 2007, essentially unchanged from the comparable and sequential prior quarter percentages.

As a final note on credit quality, I will remind you that BancorpSouth’s conservative credit operations steered clear of participation in the sub-prime mortgage market. This is clear evidence of our adherence to conservative policies. We continue to have only nominal exposure here, approximately $239,000 at the end of 2007 to those, all issues affecting the sub-prime market.

BancorpSouth produced 9.6% growth in non-interest income for the fourth quarter versus fourth quarter of 2006. Considering the continued softness in the insurance market, which first became notable during the third quarter, we are pleased with this growth and with the diversified revenue streams that contributed to its performance. This included free revenue from our credit and debit card business, which increased 16.4% for the fourth quarter and 15.7% for the year. In addition, free revenue from service charges increased 11.5% for the fourth quarter. The company-reported non-interest revenue included the negative impact of declines on the value of our mortgage servicing asset with a net impact of $545,000 and $1.2 million for the fourth quarter and for the full year, respectively, when compared to the same periods of the prior year.

In summary, because of growth conditions in the housing markets we were encouraged by 6.8% fourth quarter 2007 growth in mortgage origination revenue and the 10.1% growth for the year. BancorpSouth’s non-interest expense increased 10.0% for the fourth quarter compared to the fourth quarter of 2006. This increase primarily reflected the operations related to the first quarter acquisition of the Signature Bank in Springfield and St. Louis as well as the opening of several new loan production offices and their service bank offices. In addition, we recognize $2.3 million of urban non-interest expense related to a guarantee of business obligations associated with certain litigation matters. We expect a moderate offset in any liabilities related to these as settled and end in litigation to our proportionate share of the proceeds from the completion of their planned initial public offering.

As I have described this morning, BancorpSouth produced star results across the company for the fourth quarter and for 2007, in contrast with many of pier institutions. Our conservative strategies are designed to drive long-term growth through economic cycles. As a result, we entered 2008 well-prepared to successfully deal with this challenging environment. With the progress of fourth quarter growth and our many diverse markets that are holding up well in the current environment, we are positioned in these markets to a deliberate and proven strategy of careful expansion and to continuous and familiar markets with a dottering management team.

In 2008, we expect opportunities to continue this expansion both with organic growth and with thoughtful acquisitions. The continued allied storming potential to expand market share in our existing geographic footprint with both new and existing customers. In addition, we are pursuing opportunities to grow through the introduction of new products and services, such as, for example, the mobile telephone banking service that we helped to pioneer in 2007. BancorpSouth also has an extensive and successful history of expanding its operations into attractive new markets. We seek continuing opportunities to blow this record from within our franchise and in contiguous states.

As a result, we are optimistic about our ability to achieve our growth objectives for 2008 and beyond. Consistent with our longstanding practice, we also expect to continue to enhance shareholder value to examine repurchases of the company’s common stock and to a governing policy that has increased cash dividends all yearly for 24 consecutive years.

Thank you, again for being with us today and for your interest in BancorpSouth. After all, we will now be happy to answer any questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from Barry McCarver with Stephens, Inc. You may ask your question.

Barry McCarver

Hi, good morning, Aubrey.

Aubrey Patterson

Good morning, Barry. Thank you for joining us.

Barry McCarver

Thank you. I guess my first question relates more to asset quality. BancorpSouth has certainly done a good job so far. I am not seeing any particularly large step-ups in NPA’s. Just looking across all of your markets strictly outside of Mississippi, what do you think 2008 kind of holds in store for the bank?

Aubrey Patterson

I would like to refer that to Greg Cowsert, our Chief Lending Officer. Greg, looking at the different types of markets we serve geographically, what would be your assessment of where the most potential aces are?

Gregg Cowsert

Well, obviously, I think we will see continued pressure in the residential real estate market for a number of years. There are very strong monitoring processes in place where we do a fair amount of A&D and construction activity to amount for those lines and to pick up on at the earliest possible time problems that might be developing, so we will continue those processes to make sure to be on top of that sector because we feel that there is going to be continued weakness in that. So, I think that is where we see the most pressure coming is in that sector and of course, given the way we are right now but times are changing and we are living in more choppy waters and we will continue to reassess but we remain very vigilant because of the environment we are moving into, but I think we need to borrow some problems speaking from any market or any sector.

Aubrey Patterson

Although I will add a comment, too. I have made a passing reference to this in my earlier remarks, but we are bluffed by diversity in our markets and we we are also very fortunate to have an externally-exposed (inaudible) returning both on the ground and in our own administration group and our rated asset group. And while we view that many many years of experience in our style of lending, we are mindfult that there are areas even in the good markets that we sold and I think we have been very selective in our acquisitions and expansions. The story in the playing field that we understand. Our inch into the Florida market would obviously come to mind on your part and on analysts’ minds generally. We moved into that market very doubtfully, very carefully, and then they in a very limited way and it has been how old our list of areas to absorb as we have begun operations there, whether by good planning or fortuitous circumstance, our entry there is very small in operation and very tightly overseen and has come at a time when we already were able to identify the problems others were experiencing.

Barry McCarver

I think you anticipated my question there in regards to comments on Florida. I guess secondly and mostly for modeling puposes, looking at the reserve ratio and push that up to 1.25, barring any significant pick-up in NPA’s and given current growth levels, is that at a level now that you feel comfortable to let it run?

Aubrey Patterson

The answer is totally yes. We have gone through it in a very analytical process and when you look at our quarter by quarter result levels there, it stayed around the 1.25 range and when you look at our non-performers again, going back over up and slightly up and down fluctuations but very steady performance throughout the last four quarters, I would not mind taking coverage ratios that are rock solid, and we expect that to continue.

Barry McCarver

Okay. Then just lastly, Aubrey, you mentioned that…

Aubrey Patterson

Excuse me, Barry. Let me let Nash Allen weigh in also.

Barry McCarver

Sure.

Nash Allen

The reserve level at 1.25 is the by-product of a process that we go through yearly. That is not something that we look at when left running up into the loans until the other process is completed. And then it is reflective of our review of our loans, our classifications, any deterioration in value of the loans and the general overall condition of the loan portfolio. I mean, the loan reserve after that process could be 1.3% or it could be 1.2%. That is just the way happens to fall.

Aubrey Patterson

I think it is meaningful that it has stayed very close in a very tight range through that period, and we having done so and gone through the analytical review process that Nash has described, we talked this out, mentioned some trial-assorted steps in the third quarter to identify issues and move some items into the other real estate categories so that we have already dealt with that and prepared to deal with the relatively minor levels of ORE with no additional loss anticipated. Gregg, did you have a comment?

Gregg Cowsert

I was just going to point out that I think it is important to note that the 1.25 level of the loan officer’s oath provides a coverage for non-performing loans at 3.95 times.

Aubrey Patterson

Thank you, and so 3.9 times coverage in the reserve over non-NPO’s.

Barry McCarver

Okay. The last question, Aubrey, in regards to your comments about acquisitions as potential growth drivers. I am curious. Any particular markets, new markets that you might be looking at and anything, in the near term; it is kind of gauged. I guess the seriousness of that comment. Strictly given the fact that your stock is one of the few that has a currency to acquire with, is one of the few that has held up quite nicely in the last 12 months.

Aubrey Patterson

Thank you for noting that the operative word in what I said about acquisitions was thoughtful acquisitions. We are going to keep our powder dry. We are going to maintain strong capital. We are mindful of the very attractive dividend yield and our 24-year performance and continuous improvement in our dividend payout. All of these factors go into a comprehensive track or plan which now overlays a market environment where there will be acquisition opportunities that may have strategic value and that we are having the capability to take advantage of those opportunities, and in my experience in similar points in economic cycles over the years, provides some of the best opportunity. We are going to be very deliberate in our assessment of those opportunities.

Barry McCarver

Okay. Thanks a lot, guys.

Aubrey Patterson

Thank you, Barry. My apologies, do we have other questions?

Operator

Yes, our next question comes from Brian Clark with KBW. You may ask you question.

Brian Clark

Good morning.

Aubrey Patterson

Good morning, Brian. Thank you for being with us.

Brian Clark

When I found out that you have already covered this, I jumped out from another conference call, but the increase in ORE in the quarter about $13 million from the third quarter. Can you put on a little bit of color on what region that might be in and then what type of collateral that was?

Aubrey Patterson

I will refer to Gregg for a brief response. We did in fact have some discussion of that. The most significant fact about it. Well, a general statement as it relates to the aggregate amount is that there is to take an assertive position with some limited number of non-performers to go ahead and recognize that situation and put them in their ORE category were they can be dealt with optimally and efficiently and in the long range we calculated to maintain the right proportions through our analytical process. Having said that, your specific question dealt with whether there were any particular areas involved, and I will defer to Gregg on that.

Brian Clark

Okay.

Gregg Cowsert

It is really related to, involves build-or-develop relationships in the Alabama region.

Aubrey Patterson

I think that is a complete response that you are saying.

Brian Clark

And with these charge-offs of $1.7 million net charge-offs in the quarter. Can you tell me, I guess, how much was related to these early adds in the quarter?

Gregg Cowsert

About $2.1 million.

Brian Clark

Okay. I did know that from the press release and I did hear earlier you talked about the strong loan growth. Can you provide, maybe, a breakdown of what geographies came in?

Gregg Cowsert

Generally speaking it has been broadly-based. As we continue to note from time to time with the diversity of our markets and the relative underlying fundamental strengths of those markets have not been, in a general statement, our markets have not been as severely impacted as some of the go-go markets have been.

So we will continue to have the relative growth in all respects that we have already reported to you by numbers. We will certainly expect loan rate to be a valuable commodity in 2008 within the national economic situation, but thus far we have been able to generate organic growth at a respectable rate.

Brian Clark

Okay. And with the added comment on the insurance commissions were soft in the quarter and then there is a little bit of, you know, seasonal dip-down in the fourth quarters but yearly bounces back with the strong first quarters. Should we expect the same sort of historical trend for the first quarter of 2008 or should that be a little bit, the growth be a little more viewed in versus the past years?

Aubrey Patterson

As were the participants on the call were identified early in the call, James Threadgill is our Vice Chairman in charge of discrete lines of business in holding insurance. As you know and by the way we continue with our net revenues, 30% to more than 35% of net revenues provided by non-interest revenues, which continues to put us in the proper strategic position we want to be in, and a major component of that is our insurance operation.

So James, would you like to respond to that question?

James Threadgill

Yes, Aubrey. Brian, historically, the first quarter is stronger in our agencies, primarily as the result of receiving contingency payments from the carriers. We do anticipate the first quarter to be strong. Going back into the last year, we did make two acquisitions. Well, actually one of them was made January 1st of this year in Springfield. We acquired the property casualty of operations from Arthur Gallagher in Springfield, Missouri. While, though, in the end of the third quarter of last year, we acquired insurance networking in Jonesboro, Arkansas.

Now, those two acquisitions should help back our revenue in 2008. I will tell you that the insurance industry rates are softening. We are seeing a continuing decline in the premiums. We have been two years without a hurricane so the rates and the capacity along the coast is, the capacity is improving. The rates are coming down somewhat and so we anticipate a continuing softening in the industry but we have a very strong insurance operation. We have very capable professional insurance producers and we do anticipate, with these two acquisitions, that we will have a significant growth in 2008.

Brian Clark

Okay, great. Thanks, James. Here is my last question, for Nash. Nash, can you break out the, you have mentioned that in the partial rate the change in the par value of the MSR’s, but can you break out how much was from decay and pay down versus how much was the change in actual fair value of the MSR?

Nash Allen

Sure.

Brian Clark

Okay.

Nash Allen

In the final quarter, premiums were $1.1 million and the marked adjustment was $3.4 million.

Brian Clark

Great. All right. Thank you very much.

Nash Allen

Over $4.5 million.

James Threadgill

Just one corollary comment there, Brian. I think I may have made a passing reference to this but we are very much encouraged by the addition of a number of strong-producing originators to our team of mortgage bankers, and we are seeing funds with long terms in our new loan origination. You wanted to break out appropriately so the write-offs of value due to the actual runoffs in the mortgage portfolio, but we are seeing some considerable strength as we expand our originations and we truly expect this rate environment to provide a lot more opportunity for growth and mortgage and originations and refinancing opportunities in 2008.

Brian Clark

Okay great. Thanks for that additional comment.

Operator

(Operator Instructions) Our next question comes from Dave Bishop. You may ask your question.

Dave Bishop

Hey. Good afternoon Aubrey.

Aubrey Patterson

Hi, Dave.

Dave Bishop

I have a question and still coming back just tell me your comments on the preamble, in terms of the funding of loans versus through the flood barrings and runoff security balances.. How should we think of that playing out through the rest of us, out 2008?

Aubrey Patterson

I think we will continue along with great opportunities to provide that as a source of funding both as replacement funding for continued runoff of public fund CDs which require being secured as well as to provide a world-priced source of funds for new long growth as we continue to grow the portfolio. It is obviously a peer-pricing decision but our continued use of that source of liquidated does fill up the investment function of the bank from having to acquire securities strictly for pledging purposes. So, all of that has a salutory effect or net effect that I have described earlier on our spreads. I think we will continue to be able to utilize the home loan bank borrowings very effectively as a component-based, not an exclusive source but a component based upon aggregate source of funds. With the rate environment is changing, it has been rather dramatically here this week that certainly has reflected itself in the cost of the borrowings as well.

Just as a sort of an editorial comment.

Lending banks, including some rather larger institutions obviously have liquidity issues that they are having to deal with than more aggressive CD pricing. We are intent on protecting our core deposit customers and we priced very competitively in local markets but we are not dependent on CD funding to the degree that I perceived some of our peers and some of the larger regional banks must be by their pricing. Given that, I think it gives us an additional advantage in utilizing home loan bank borrowings and we have an extraordinary broad capability to expand those borrowings.

Dave Bishop

Can you tell us in a sense what those rates are looking like now in terms of the flowback system versus maybe what you would be paying at the public funds?

Aubrey Patterson

It depends. There is a dip in the yield card. It depends on what maturity you are at. But again, we do not much dollar for dollar the rates of some of the highest rates that are out there in the market place on the CDs but when you look at it, there can be a 100-150 basis points difference in the same maturities on CD prices that are being posted by some of the larger regionals versus funds that are available to the home loan bank.

Dave Bishop

Got you. Circling back to Brian’s questions, I think he talked about this in the beginning of mortgage origination volume of this quarter. How does that compare versus the prior quarter of last year? Thanks. .

Aubrey Patterson

Our origination volume for the quarter was $215 million and the same quarter last year was $159 million. So it was less significant. About a year, we were $876 million of originations. That was up 42% of the prior year.

Dave Bishop

42%?

Aubrey Patterson

$8 million.

Dave Bishop

Aubrey, maybe you can give some commentary. I know, I think we have had you on the row before. There has been some commentary regarding the local Memphis mark in terms of the housing there. What do you see there in terms of recent trends and developments?

Aubrey Patterson

Obviously, there is a national excess of inventory in the housing, inventory that is available and developable and developed a lot. Memphis is no exception to that. One of the major problems in the Memphis market dwells with the legacy banks; they are still there obviously and are our formidable competitors but we are essentially in that same group in terms of relative significance as a player in the Memphis market.

Dave Bishop

All right.

Aubrey Patterson

Once again, reducing our expenditure to real estate development and construction and lending in the residential real estate arena in Memphis well over a year ago, we feel very comfortable. Well, comfortable might not be the right word in any environment having to do with real estate today, we but we are very confident that we are dealing with clients who have staying power, who have not been overexposed and who have liquidity sufficient to maintain their operations well. In short, we do not view that municipal market as an area of significant exposure to us. Having said that, it would be naïve to belong to the extended downturn in the housing market to last beyond 2008 or mid 2009, will not have an impact on our borrowers even though our borrowers are of the highest quality, just as it would allow individuals that are enaged in real estate. We now view Memphis as an area of significant overexposure for us.

Dave Bishop

Great. Thank you.

Aubrey Patterson

There are no further questions at this time? I do have one other correction. Ms. has reminded me that I have been dyslexic this morning and I thank you, Randy. I only indicated that our exposure to the same card and loans was $239,000 as if that was not considered to buy…I want it to be a material amount but in fact, it is $329,000 not $239,000 so just to keep the record straight. I want to thank you Randy for correcting me and thank you all for your questions this morning and for your continued interest and support our BancorpSouth. If you need additional information or have any further questions, please do not hesitate to call Nash Allen or myself. Otherwise, we look forward speaking with you again after the first quarter. Good day.

Operator

Thank you for participating in today’s conference. You may now disconnect at this time.

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